The Tenth Circuit, after a long period of deliberation, has reversed the Tax Court in Salman Ranch. (Opinion linked here.) This now makes the score 3-2 in favor of the government in the series of appeals that have spread to most circuits. See our original report here.

The Tenth Circuit’s opinion closely tracks the reasoning of the Federal Circuit in Grapevine. The court first looked at the Supreme Court’s decision in Colony and concluded that it should not be read as holding that the statute unambiguously supports the taxpayer’s position. (The Tenth Circuit did note its disagreement with the Seventh Circuit’s conclusion in Beard that the statute unambiguously resolves the issue in the government’s favor.) Having found that Colony was not an obstacle to the issuance of valid Treasury regulations, the court proceeded to apply the Chevron test to the regulations and, like the Federal Circuit, ruled that the regulations surmounted the relatively low bar of being a reasonable interpretation of the statute. The Tenth Circuit stated: “Although we are not convinced the IRS’s interpretation is the only permissible one or even the one we would have adopted if addressing this question afresh, we are satisfied that it is a ‘permissible construction’ within the mandate of Chevron.”

The Salman Ranch case presented one interesting wrinkle not found in the other Intermountain cases. The Salman Ranch partnership had already prevailed on the identical issue in the Federal Circuit for a different tax year. SeeSalman Ranch Ltd. v. Commissioner, 573 F.3d 1362 (Fed. Cir. 2009). Ordinarily, that decision would have collateral estoppel effect in other litigation on the same issue between the same parties, and therefore it would have controlled the outcome in the Tenth Circuit. The Tenth Circuit ruled, however, that there was no collateral estoppel effect because the “rules” had changed in the interim — because of the issuance of the new regulations. The Federal Circuit had observed in Grapevine that the Chevron doctrine gives “regulatory agencies, not the courts, primary responsibility to interpret ambiguous statutory provisions.” The Tenth Circuit’s decision goes that statement one better with respect to the power of agencies to make law, at least in this particular context. It potentially gives regulatory agencies more power than even Congress to change the law, as Congress usually does not act retroactively when it enacts new legislation to overturn a court decision. Without retroactive effect, new legislation would not destroy the collateral estoppel effect of a court decision.

If the taxpayer wishes to seek rehearing, the petition would be due on July 18. By that time, the issues could be on their way to the Supreme Court because the government’s deadline for seeking certiorari in Home Concrete, the most advanced of these cases, is July 5.

The Supreme Court this morning granted certiorari in one case, Kawashima v. Holder, on which we have been reporting for some time. See our original post here. As we observed in our report on the cert petition, the Court always has the option of limiting its grant of certiorari to a subset of the questions presented in the petition, and it has exercised that option here. The Court will resolve only the first question presented — namely, whether violations of 26 U.S.C. 7206 (subscribing to a false statement on a tax return) are “aggravated felonies” that can justify deportation of a resident alien. The Kawashimas argue that only tax evasion convictions under section 7201 are aggravated felonies, and the courts of appeals have divided on the issue. Now the Supreme Court will resolve the dispute.

The case will now be briefed over the summer and argued in the fall of 2011, with a decision likely in the spring of 2012. The Kawashimas’ opening brief is due July 7.

The government has filed its brief in the Third Circuit in PPL. The brief is virtually identical to the brief filed a few weeks ago in the Fifth Circuit in Entergy that addresses the same issue of the creditability of the U.K. Windfall Tax under Code section 901. See our initial report here. The only significant differences are addressing PPL’s facts instead of Entergy’s and placing more weight on Third Circuit precedent instead of Fifth Circuit precedent. The essence of the government’s argument is that the section 901 determination should be based entirely on the text of the foreign statute, and therefore the Tax Court erred in considering extrinsic evidence of how the tax operates. Because the U.K. statute uses the term “profit-making value,” the government says that it is a tax on “value,” not an “income” tax, and therefore it should not be creditable.

As we’ve reported in the last few months, several securities lending cases are percolating in the appellate courts (see here and here). On April 29, 2011, Anschutz Company filed the opening brief in its appeal of the Tax Court’s decision for the government (opinion and brief linked below).

At issue in Anschutz is the appropriate tax treatment of a set of transactions between the taxpayer and Donaldson, Lufkin & Jenrette Securities Corp. (“DLJ”). The taxpayer sought to leverage long-held shares in publicly-traded railroad companies to obtain financing for other endeavors. In the taxpayer’s hands, the shares had a low basis relative to their fair market value at the time of the transactions in question. The transactions involved the use of prepaid variable forward contracts (“PVFCs”) and concurrent share lending agreements (“SLAs”). Under the PVFCs, DLJ paid the taxpayer a percentage of the current market value of the shares in exchange for the right to receive a number of shares or their cash equivalent at a point in the future. The number of shares to be delivered (or their cash equivalent) was to be determined by a formula agreed upon at the outset. In order to secure its obligation, the taxpayer pledged a number of shares sufficient to ensure consummation of the deal at maturity. In parallel, DLJ entered into an SLA with the taxpayer under which DLJ would take possession of the pledged shares to use them in short sale transactions. Although each of the two transactions, viewed in isolation, would have passed muster under relevant authorities as non-taxable open transactions, the government challenged the arrangement as constituting in substance a taxable sale of the shares at the inception of the deal. After a two-day trial, the Tax Court agreed.

On appeal, Anschutz argues that the Tax Court’s decision to view the transactions as two legs of one overall arrangement was error. Rather, the taxpayer contends that the two transactions should be respected as stand-alone occurrences to be analyzed separately. Under the taxpayer’s view, the PVFCs are non-taxable open transactions under Rev. Rul. 2003-7, and the SLAs fall within the ambit of I.R.C. section 1058 (stock loans not taxable provided certain conditions are met). For the Tax Court, the crux of the case was that the PVFCs had the effect of shifting to DLJ all risk of loss and most of the opportunity for gain on the shares. Under section 1058, a stock lending arrangement cannot reduce the risk of loss or opportunity for gain if it is to be considered non-taxable. The taxpayer contends, however, that in spite of a master agreement governing both legs of the arrangement, the facts properly construed require the two transactions to be analyzed separately as independent deals, each with their own tax consequences.

The government’s response is now due on June 24, 2011. We’ll keep you posted on this and other developments in the securities lending cases.

The Supreme Court was expected to announce this morning whether it would grant certiorari in the Kawashima case, but today’s order list contained no order in the case. Instead, the Court has “relisted” the petition for consideration at this week’s conference. That means that the case has caught the Court’s attention and distinguished itself from the mass of cert petitions that are routinely denied, with some of the Justices determining that the petition warrants more careful study. Although the odds that the petition will be granted have increased, it remains true that most cert petitions are denied, even the ones that are relisted. (That is what happened last month with the State of Virginia’s cert petition seeking immediate review of its challenge to the constitutionality of the new health care legislation.) If the Court is ready to decide on the Kawashima petition this week with the benefit of another week to consider it, the order denying or granting certiorari would be announced next Monday, May 23.

The taxpayer has filed its answering brief in Entergy defending the Tax Court’s decision that the U.K. windfall tax is a creditable tax for purposes of the foreign tax credit under Code section 901. See our original report here. According to the taxpayer, the essence of the government’s argument is that “the creditability of a foreign tax can be determined only by the literal text of the foreign tax statute, and that the consideration of any other evidence is legal error.” This position, the taxpayer argues, is rebutted by “overwhelming authority establishing that the predominant character of a foreign tax is measured by its intent and effect,” which requires resort to evidence beyond the text of the foreign statute.

The taxpayer also argues that the government has mischaracterized the Tax Court’s decision in stating that the court ignored the three-part regulatory test for creditability. Instead, the Tax Court correctly heard evidence of the intent and effect of the U.K. tax to determine its predominant character — namely, a tax on excess profits — and then applied the three-part test to that predominant character.

The en banc Federal Circuit heard oral argument in the Bush TEFRA case on Wednesday the 10th of May. For those still interested after reading this, you can listen to the argument here. As we indicated in our prior analysis, we think the resolution of this case is simple. Unfortunately, although the parties and the court almost escaped the weeds several times, with one of the judges asking a question very close to the mark, it was a dissatisfying oral argument (from our perspective). The point that needed to be made is that an agreement to “no change” a partnership item is “treatment” of a partnership item in and of itself — you have just treated it the same as it was originally treated. Thus, a change in tax liability that “reflects” a partnership no change is a computational adjustment.

To put some more meat on that, section 6221 illustrates the purpose of TEFRA to require “the tax treatment of any partnership item [to be] determined at the partnership level.” Section 6230(a) coordinates the Code’s deficiency proceedings with TEFRA and mandates that, aside from converted items, notices of deficiency are required only for “affected items which require partner level determinations.” Claims arising out of erroneous “computational adjustments” can be litigated but the underlying treatment of partnership items resolved in a TEFRA proceeding cannot be re-litigated. Section 6230(c). Section 6231(a)(6) defines a “computational adjustment” as a “change in the tax liability of a partner which properly reflects the treatment … of a partnership item.”

Where you have a change in tax liability of a partner that “reflects” the “treatment” (not the “change” in treatment, just the treatment) of a partnership item and no partner-level determinations are necessary, then no notice of deficiency is required. In Bush, the partners settled the “treatment” of the partnership items as a no change and agreed to all of the necessary partner level determinations so there was no need for a partner-level determination to determine tax consequences. Accordingly, no notice of deficiency was necessary. Contrary to the taxpayers’ position at oral argument (and in the briefs), the fact that there could be other (non-partnership) items contested in a notice of deficiency is irrelevant. Likewise, it is irrelevant that the partnership items or treatment of those items never changed. You don’t need a change in a partnership item or a change in the treatment of that item to have a computational adjustment. Instead, you need a change in tax liability that reflects the treatment of partnership items. Any TEFRA-based adjustment does that even if the partnership items stay as they are on the original return because their treatment is reflected in that tax liability. That is the whole point of TEFRA: partnership item treatment is relegated to TEFRA proceedings and everything flows out of that treatment. So a change in tax liability driven by a change in allowed partnership losses based on a change in a partner’s at-risk amount reflects the treatment of a partnership item (the losses, which are no-changed, which is a form of “treatment”) and thus is a computational adjustment.

Although the court asked several questions on the period of limitations and assessment issues and asked other questions to determine the scope of the problem, the rest of the taxpayers’ arguments are a sideshow. It is always tough to tell how a case will be decided based on the arguments, but, even though it was less than satisfying, the court’s questioning indicates to us that the government will prevail and the court will find its way out of this part of the TEFRA forest.

After four extensions, the government finally filed its response to the petition for certiorari in Kawashima. As we previously reported (see here and here), that petition raises a question on which the courts of appeals are in conflict — whether a tax offense other than tax evasion can be an “aggravated felony” for purposes of the immigration laws, which would justify deportation of a resident alien. Maybe the government was spending all that extra time considering whether to “acquiesce” in the petition and invite the Supreme Court to resolve the conflict, or maybe it was just taking its sweet old time. In any event, the government has filed a brief urging the Court to deny certiorari.

The brief in opposition acknowledges that there is a conflict in the circuits, terming it “a narrow disagreement.” But the government argues that there is no need for the Court to resolve that disagreement. In particular, the government argues that the Court’s recent decision in Nijhawan v. Holder, 129 S. Ct. 2294 (2009), supports the government’s position and, since the Third Circuit’s contrary decision was issued before Nijhawan, “the narrow disagreement in the courts of appeals may be resolved without further intervention of this Court.” On the merits, the government resists the petition’s statutory construction analysis by arguing that “fraud or deceit” is not necessarily an element of tax evasion under 26 U.S.C. § 7201. If it is not, then theoretically 8 U.S.C. §1101(a)(43)(M)(ii) is not superfluous, as the petition argues.

In their reply brief, petitioners vigorously contest the government’s premise that “fraud or deceit” is not necessarily an element of tax evasion under 26 U.S.C. § 7201 by analyzing the structure of the Code’s criminal tax provisions. Among other things, petitioners state that the government’s “reasoning defies logic: the greater offense [section 7201] does not necessarily involve ‘fraud or deceit,’ but the lesser offense [section 7206] necessarily does.” With respect to the government’s assertion that this circuit conflict does not warrant the Supreme Court’s attention, petitioners maintain that the need to stop unlawful deportations presents a compelling reason for Supreme Court review.

The Fifth Circuit yesterday issued a short, unpublished opinion affirming the Tax Court’s decision in Container. As discussed in more detail in our earlier post, the issue is the sourcing of guarantee fees charged by a Mexican parent to guarantee notes issued by its U.S. subsidiary. The Fifth Circuit ruled that the issue turned to a considerable extent on the Tax Court’s factual findings concluding that the fees were payments for services, which it found were not clearly erroneous. The Fifth Circuit concluded that the Tax Court’s ultimate characterization of the fees as foreign-source income was correct because they were payments for a service that was performed in Mexico — namely, the parent’s provision of the guarantee. The government had argued that the guarantee fees were more in the nature of interest that should be sourced to the United States.

This decision is of limited significance going forward. As we previously noted, Congress has already acted to reverse the result of this case for future years by enacting legislation specifically providing that a guarantee fee paid by a U.S. company is U.S.- sourced income. And the opinion resists making broad pronouncements about sourcing analysis, largely confining the discussion to the facts of the case. Indeed, by declining to publish the opinion, the Fifth Circuit has deliberately sought to minimize its precedential value. Under Fifth Circuit Rule 47.5.4, unpublished decisions may be cited, but they “are not precedent, except under the doctrine of res judicata, collateral estoppel or law of the case.”

A petition for rehearing, should the government choose to file one, would be due on June 16.

About Miller & Chevalier’s Tax Appellate Blog

Miller & Chevalier was founded in 1920 as the first federal tax practice in the United States. For nearly 95 years, the firm has successfully represented the most sophisticated corporate clients in all facets of federal income taxation. Miller & Chevalier’s Tax department serves clients headquartered throughout the U.S. and around the world and, over the past several years, has represented approximately 30 percent of the Fortune 100 and more than 20 percent of the Global 100. Our clients come to us to solve the thorniest of tax issues, and we have litigated many of the most significant tax cases on record.

The Tax Appellate Blog is intended to be a resource for information on important tax cases under consideration in the appellate courts. It will feature insightful commentary on the issues and provide a dedicated site for following the progress of these cases.

Authors

Steve Dixon is a Member in the Tax Department at Miller & Chevalier. He specializes in controversy and litigation, representing taxpayers in the Tax Court and Federal courts.

Laura Ferguson is a Member of the Supreme Court and Appellate Litigation Group at Miller & Chevalier and has successfully briefed and argued six cases at the U.S. Courts of Appeals in the past two years. Ms. Ferguson also has extensive experience litigating complex, high-stakes tax cases at the Tax Court and federal district courts.

Alan Horowitz is the former Tax Assistant to the Solicitor General at the Department of Justice, where he briefed and argued numerous tax cases in the Supreme Court. He is currently the head of the Supreme Court and Appellate Litigation Group at Miller & Chevalier.